Can target benefit plans work?

More than four years have passed since expert commissions in Ontario, Alberta, B.C. and Nova Scotia all endorsed target benefit plans (TBPs). TBPs are generally regarded as superior to DC arrangements since longevity risk is pooled and the intractable problem of educating a diverse population on myriad investment options is neatly circumvented by having one common fund. TBPs are also more suited to collective-bargaining situations since all members have the same investment return. Assuming that traditional DB pension plans are no longer viable in industries with volatile profitability—which means most industries—TBPs are the way to go.

There are two problems, however. The first is that provincial governments have been slow to introduce enabling legislation. Nova Scotia converted its civil service plan to a TBP but has yet to release regulations governing what private sector sponsors can do. Alberta and B.C. plan to roll out TBPs but not until well into 2013 at the earliest. Quebec needs to act soon on TBPs since Resolute (the former Abitibi-Bowater) recently negotiated TBPs, but we do not know yet what form that action will take. Notably quiet are Ontario and the federal government, both of which seem to have put TBPs on the back burner, if they are on the stove at all. Historically, Ontario has taken a leadership position in pension reform but seems content now to follow. The federal government recently upped the retirement age for the federal public service plan but chose to steer clear of any TBP-like changes. The one province that has acted quickly, and intelligently, is New Brunswick.

The delayed introduction of TBPs has forced companies that can no longer afford DB plans to resort to inferior plan designs. Air Canada and the Big Three auto companies, for instance, both adopted a two-tier arrangement that is one part DB and one part DC. This type of arrangement poses problems from the standpoint of governance, complexity and administrative cost, but TBPs weren’t available when these two-tiered arrangements were negotiated.

The second problem is that it is not clear that TBP legislation will allow for retrospective application, which would allow TBPs to apply to past and future service rather than just future service. The fear is that pension legislation in most provinces will allow TBPs to be implemented for future service only since this is the path of least resistance. A future service-only approach means that employers that currently sponsor DB plans would need to maintain a different governance regimen and funding policy for past and future service, and also put up with more complicated valuation, member communication and administrative processes. If so, employer interest in TBPs is bound to be minimal.

There is a glimmer of hope, though, thanks to New Brunswick. Its new shared risk plan (SRP) model (a variation of TBPs) allows TBP rules to be applied to both past service and future service benefits, including pensions already in pay for existing retirees. No grandfathering needed. If, after conversion to an SRP, a pension plan fails specified funding targets, the plan trustee must reduce basic and ancillary benefits.

While this arrangement may seem a little too employer-friendly for some tastes, it is important to note that plan members’ interests in New Brunswick are protected in several ways. First, SRPs must be independently trusteed. Second, substantial risk management processes are built into the SRP model, and these minimize the possibility that accrued benefits will have to be reduced. Third, the employer gives up any rights to any surplus that might develop in the future.

New Brunswick’s creation of the SRP concept with retrospective application is a near-miracle that required an exceptionally high degree of co-operation and willingness to effect change on the part of government, management and labour. In the development process, the province realized the shared risk model would work better if applied to both past and future service, so it was only fair to extend the same choice to private sector plans.

It remains to be seen whether or not the other provinces will follow New Brunswick’s lead. The difference is that most other provinces will probably lay down TBP rules before they consider a TBP for their own employees. They might, therefore, not appreciate the importance of retrospective application as much as New Brunswick did. A provision that is common to pension legislation across the country is that accrued benefits cannot be reduced, and any amendment that purports to do so is declared void. Can other provinces bring themselves to override this provision by allowing a TBP to replace an existing DB promise for past service? If not, TBPs might never get off the ground, and a promising design solution will wither on the vine. If yes, TBPs might eventually be recognized as the ideal retirement plan for the 21st century that neatly balances the interests of employers and employees.

Fred Vettese is chief actuary of Morneau Shepell. These are the views of the author and not necessarily those of Morneau Shepell or Benefits Canada.